International business opportunities lead a growing number of companies to develop their routes to market around the world. For many, this means forming distribution networks, often using agents and remarketers.
Many are not aware of the very different rules that apply to such relationships in overseas jurisdictions. These range from issues under competition law to more specific regulations that are designed to protect the local entity. In Europe, for example, companies encounter not only the EU laws and regulations, but also a raft of local provisions that focus especially on rights of termination.
When I met recently with lawyers from one of the top French law firms, they mentioned that disputes with a local distribution partner had become the most common area of commercial litigation in the Paris courts. Now comes an interesting example from Germany. In a case which has gone all the way to the German Supreme Court, a company based in Virginia, USA has been successfully challenged over its choice of law and jurisdiction provision. Essentially, the German courts have decided that the US court cannot be trusted to apply agency terms that are mandatory under German law and which safeguard the rights of the German sales agent. Therefore they have overturned the choice of law provision and deem the US principal to be answerable to the German court.
This determination means that a company must carefully study the local provisions relating to distribution channels and perhaps use these in determining its route to market decisions. It can no longer assume that local legal or statutory provisions can be eliminated simply by relying on an alternative jurisdiction or choice of law.
ISG recently released a brief report on 2012 trends in outsourcing. They comment upon the divergence between markets, which inevitably reflect the variations in economic conditions and business confidence.
In Europe, much of the focus appears to be on cost-cutting, with pressure for utility pricing, limited commitments and short-term returns. Asia is also experiencing anxiety over costs and flexibility, as they deal with a rapid slow-down in local markets and regional growth predictions. This has apparently led to ‘innovative contracting’, with a trend towards ‘assured outcomes’ and strong focus on IT outsourcing.
This leaves the US as a market that continues to cut back on its use of outsourcing and shows far more interest in innovation and transformation. This perhaps reflects the growing confidence of US business that it can effectively compete with new global competitors. This has lessened the need for labor arbitrage in previously low-cost markets and increased the pressure to develop new products, services and business process.
For providers, market conditions remain tough, with significant competition and the need to manage the complexity of divergent markets. However, as the report indicates, there is a growing ability to differentiate not only in terms of the services offered, but also in the range of contract structures and commercial offerings.
Yesterday I presented at a meeting of supplier relationship managers. My theme was ‘Driving Contract Performance Through The Fear Of Failure Just Doesn’t Work…’ and it focused on the need to understand how contracting practices influence behavior and outcomes.
I started by raising questions over the importance of contracts and one co-presenter was quick to raise her hand and tell me ‘We don’t have contracts with our key suppliers’. We had a brief discussion about the implications of ‘no contract’ and it later emerged that while this company has no traditional agreements, it does have a disciplined approach to defining the relationship and how it will be managed. Not surprisingly, there are also documents that sound very similar to Service Level Agreements and Statements of Work.
So in the end, there are essentially ‘contracts’, even if the organization chooses to call them something else. And if they feel this in some way contributes to better relationships with their suppliers, I think that is fine.
The real point here is that contracts matter far less than the contracting process. A good contracting process evaluates how best to structure and manage an organization’s assets – and those assets include their trading relationships. So if you can manage risks and achieve better results through non-traditional forms of agreement, then that is the right decision.
A problem at most organizations is that they tend to have a standardized approach to contracts which rarely allows for discussion of commercial alternatives. As a result, anyone deviating from the system often does so without having adequately explored the implications or alternatives.
I am excited about the break-throughs we are making in truly defining the value of contract management. Or to put it another way, the cost to organizations when they fail to develop strong capabilities in this area.
In previous blogs I highlighted IACCM’s early research into the return on investment from contract management. This was interesting and ground- breaking. But it was also generic and therefore begged the question “Is this really representative of my organization?”
The new news is that an increasing number of IACCM member companies are using those initial insights as a springboard to undertaking detailed internal analysis of their contract portfolio. This may be though a targeted effort, say focusing on a specific category of contracts, or it may be across the board. Some have examined just 20 or 30, while others have started to monitor and track thousands.
The important point is the results, which largely support the initial research findings. They confirm that there is tremendous value waiting to be mined through improved contracting practices and process. Buy side and sell side analysis both reveal large potential for bottom-line benefits. For example, one large corporation discovered that some 29% of its sales contracts underperform. They also identified six key areas that led to this – and that the average underperformance was 22% of planned revenue. Now a plan is in place to tackle this leakage, with the expectation that it can be halved this year. That will bring approximately 2.5% extra revenue to the bottom line – or around $500 million.
In order to gain these rewards, a business must shift its attitude to contracting and see it as a process. Improvement comes from analyzing the contracts portfolio to identify reasons for loss and then, of course, taking steps to fix them. This may require redefining roles within the organization. It certainly demands a shift in appreciation of the value of contracts and that the process can be used to test internal performance.
Here is a brief example. One area where there are frequent problems is contract scope. Weaknesses in definition cause disagreements between buyer and supplier, with many negative consequences. So this calls for further thought about the way requirements are identified, analyzed and discussed, as well as the process and people through which they get documented. But while this will yield improvements, it will also reveal the fact that today’s fast-moving business environment means that scope will often change. So the parties actually need to think about the post-award mechanisms through which change – and associated risks and costs – will be better managed.
Many of the sources of loss are actually much simpler than this one. They are due to terms that were omitted, or unauthorized discounts that are processed, or personnel who have not received training or have no access to commercial guidance.
As I mentioned at the beginning of this blog, I am excited by what we are discovering because at last there is a compelling executive message. Contract management is a critical source of value realization – and we can show you the money!
What are the underlying principles that drive contracting behavior and attitudes at your organization? And how important is the role of contracts in delivering business value or organizational goals?
These are questions that a current IACCM survey seeks to answer (Click here to view or complete the survey). It is clear that the factors influencing contract policy and practice vary widely – and this may increasingly be true in the division between Government and the private sector. For example, this quote from the UK’s Guardian newspaper illustrates one aspect of the divide: “Central government’s primary driver is still cost reduction. Yet whilst cost reduction is still one of the private sector’s top five drivers, other drivers such as increasing customer satisfaction and innovation in order to attract new customers are rapidly gaining in importance.”
IACCM observes growing evidence that organizations appreciate the importance of revising their contracting practices and process, in some instances to raise efficiency, but in many cases to generate better business results. Yet conflicting views and drivers make it more difficult to negotiate and build sustainable relationships. Our survey will reveal the current trends and to what degree they are affecting particular industries or geographies.
This year has seen big changes in the world of patents, with significant developments in the US and the EU.
After years of discussion, the EU accepted the need for a unified system that overrides the previous need to register country by country. The Unitary Patent should be in effect by early 2015, making the filing of patents within the EU far ore attractive and massively less time-consuming and expensive.
At the same time, with effect from last March, the US was overhauling its system under the auspices of the America Invents Act. An important feature of that Act is the ‘ first to file’ principle, which is certainly likely to boost the number of patent applications.
Globally, the use of patent systems to protect IP continues to gather pace. The World Intellectual Property Organization (WIPO) reported 10.7% growth in 2011 and 6.6% in 2012. Of course, it is not possible to know how many of these patents have real merit and to what extent they will be used in efforts to prevent competition or extract money from real inventors. At least one encouraging piece of news was last week’s Execution in the US to limit ‘patent trolls’.
WIPO also commented on the drive by corporations to register intangible assets since these now play such a large part in market valuations, Certainly this implies negotiations over IP rights will remain high on the agenda for the ‘most negotiated terms’.
Of particular interest is the extent to which the source of new patents is changing. For example, last year, the top four filers of new patents worldwide were all from China and Japan (ZTE, Panasonic, Sony and Huawei). Almost 40% of patents came from China, Japan or South Korea – up from less than 8% 20 years ago. If these intangibles genuinely do reflect relative wealth and value, this is a major reinforcement of the shifting global balance.
In previous blogs, I have referred to the opinion of Lou Gerstner, former Chairman and CEO of IBM, that ‘contracts are about brand image’.
Gertner’s point – which I consider very insightful – was that organizations must achieve alignment between the ‘marketing promise’ and ‘the contractual commitment’. Far too often, this is not the case. The implied values and promises that are delivered via the marketing and sales channel are then compromised or overturned by the small print of the contract. Gerstner grasped this point at a key transitional stage in IBM’s history, perhaps because of his consumer-oriented background. The corporation faced a dramatic surge in competition. It had customers demanding integration, inter-operability, global consistency and capability. IBM was seeking to respond, offering ‘solutions for a small planet’. But for the customer, those enticing words rapidly proved to have little substance.
First, the contract denied inter-operability. The customer took responsibility for operational performance via a ‘selection and use clause’. As for consistency, each country defended its autonomy by insisting that their market was different and therefore the range of features, functions, support services had mushroomed out of control; no one had any idea what could or could not safely be committed in terms of product or service availability. And that was just the start of the customer nightmare, because each country also made local contract variations; Finance wanted to exploit international price differences; and local operations and IT groups felt the necessity to develop local systems and support that allowed no central visibility. ‘Solutions for a small planet’ was actually more an indication of everything that was wrong with IBM, rather than a description of value and capability. A great concept, but not a reflection of reality.
You might think that groups such as Marketing, Sales or senior management would have rapidly grasped this point. But instead they saw ‘commitment reform’ as far too difficult. Sales were taught to tell the customer ‘Don’t worry about what the contract says, it’s what we do that matters’. And management invested in Special Bid teams and expert flying squads of negotiators who were similarly disempowered in practice. Those who ‘owned’ contracts (the lawyers and Business Practices staff) saw themselves as custodians of the status quo, not change agents. Indeed, the customer was seen as ‘trying to game us’ (in the words of one senior executive in Finance). Only with Gerstner’s backing did fundamental change prove possible, using an analysis of customer commitment requirements to drive reform of policies and practices across the business. Until that moment, contracts were indeed ‘an inconvenient truth’ – focused only on reflecting the business reality, rather than being used as a tool to drive a response to validated market need.
This seems to me to be true of so many corporations even today. The failure by Marketing to grasp the fundamental connection between their efforts and the role of the contract means that often companies generate an aura of dishonesty. Far from engendering confidence and trust, contracts tell the unfortunate truth.
As a post-script, it should be noted that IBM’s re-engineering efforts proved highly effective and restored its market position. It rapidly turned its international presence from a source of problems into the source of competitive advantage that it needed to become. The development of a strategic view of contracting – and creation of global capability in contract management – was a significant contributor to that success.